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February 04, 2003

New Retirement Accounts

I've made no secret of the fact I'm generally of the opinion that the words "Republicans" and "taxes" are just grown-up words for "children" and "matches," so you can imagine my utter shock and horror at learning of a tax proposal from Dubya and his cronies that (in theory, at the very least) I can get behind. Last week, the administration floated some changes in long term savings accounts, allowing Americans to save after-tax income in accounts that would subsequently be tax-free. You haven't heard about it because among other things a shuttle blew up. But they're out there.

These come basically in two flavors. The first would be Retirement Savings Accounts, which would allow people to save $7,500 of their income a year (a figure which would apparently be adjusted for inflation as time goes on) into a retirement account. The money put in would be taxed (i.e., it counts as part of your income for the year), but it's not taxed when you take it out (which you'd start to be able to at age 58, as opposed to 59 1/2 for IRAs today). Basically, it's a Roth IRA with a higher contribution ceiling.

Without knowing too much more about the details, I have to say I'm all for this. Roth IRAs rock in a general sense, because they allow you to take a small amount of tax pain now so you don't have to take a huge amount of tax pain later -- which is to say it's easier to pay taxes on the (currently) $3,500 or whatever you're putting into your Roth IRA now, then pay taxes on what you take out of it when you retire and your retirement savings count for a large portion of your total income (i.e., when you're going to need every penny you can get for your heart pills and heat).

And speaking as someone who is self-employed and lacks all the 401(k) bennies worker drones get, my biggest complain about how IRAs are structured is that you can't put enough of your money into them. I'm showing my class structure here, but a $3,500 yearly limit on IRA contributions is criminally stupid and low. $7,500 a year would put everyone who contributes to a retirement account into a much better position, just from compound interest alone. Also, the proposal would mean that anyone could sign up for a retirement account -- currently certain people above certain income levels can't establish either traditional or Roth IRAs (which, um, came as a mildly panicking surprise to some certain individuals). So by all means, sign me up.

The second flavor is more philosophically interesting but probably politically a trouble maker -- the Lifetime Savings Accounts, which allow people to save $7,500 a year, tax-free, for anything they want whenever they want to get it. Ostensibly, these accounts could be used for medical and educational expenses (and indeed, under Bush's proposal, it would replace current federal medical and educational savings accounts, which could be rolled over into them), but if you just wanted to spend it on video games and gum, you could do that too. The report I linked to higher up in this suggests that the LSAs would work like a traditional IRA (tax-free to contribute but distributions are taxed) while a Wall Street Journal article suggests it's going to be like a Roth -- given who Republicans are and how they'd generally prefer to structure their taxes, I'll side with the WSJ on this one and assume it's a Roth-like structure.

This one's problematic because there are no restrictions on it -- unlike the RSA, the money to fund this savings account can come from anywhere (i.e., it doesn't have to be income from work), and there are no limits on distributions. So in that regard it undercuts the RSA to the extent that most people, given the choice between putting their money into an account where they can't easily access their cash for decades, and one they can access right this second, are going to pick the latter account -- and because they can access the latter account whenever they want, as a practical matter its overall utility as a savings account is likely to be rather low.

Let's be honest and admit that one of the unheralded benefits of the IRA set-up (and that of the various other federal savings plans) is their stern single-mindedness of utility. No, you can't have this now, the IRA says, sternly wagging its finger as you try to grab some of your money for that Cancun vacation. You're going to need it when you're decrepit and the children stop calling. You'll thank me later. And we tromp off muttering, knowing that the IRA is right, even though Cancun is calling. Without that waggling finger, the Mexican economy is likely to benefit from a bunch of nice tax-free vacations. And while that's good for Mexico, it's not so good for those vacationers' eventual retirements.

This is the cue for Republicans to chime in and note that people would still have the choice between the RSA and LSA, and anyway, it's obnoxious of me to assume that people aren't fundamentally intelligent enough to make the right choices about their own money. But I don't know that it's so much a question of intelligence as a question of perspective. The number of 22-year-olds with IRAs could fit on a head of a pin, even though basic compound interest means that even a little saved at 22 is going to translate to big payouts 50 years down the line. But people don't think about things that are going to happen at a point in time twice as far away as they actually lived.

Given the general savings level in the US (in which half of us save less than $1,000 a year, according to the Consumer Federation of America), and that more than half of us are way behind in our retirement savings as it is (same source), it's fair to say that people don't prioritize savings, and that they prioritize more immediate and possibly less-than-critical expenses over retirement.

In short, I have little doubt that people would fund (and withdraw from) their LSAs far more than they will fund their RSAs, and will subsequently save rather less than they could for retirement. So while on a philosophical level I don't have any problems with the LSA (who wouldn't want to save money tax-free?), on a practical level I see political trouble ahead for it. Like it or not, people do need something with a penalty involved to get them to save for the long run, and the LSA ain't it.

So naturally, you can assume that I assume that the LSA is really what Bush and his pals want, and the RSA is a sop thrown in as a distraction. The LSA is, fundamentally, a no-restrictions capital gains tax cut, and while everyone can take advantage of it, again as a practical matter it will be most useful for the high-income sorts who have the ability to park $7,500 a year and not have to think about it again for a couple of decades. The average schmoe making $40,000 a year is neither liable to fully fund an LSA nor liable to resist dipping into it on a regular basis, so while it still has utility for him, its full, most useful benefit as a compound interest engine devolves to the upper classes (who can of course also fully fund an RSA as well). It's more proof that all the way around it's simply better to be well off than not -- and that's easier to be rich and stay rich, than to be poor and get rich (or even somewhat comfortable).

Whatever the ultimate fate of the LSA, I certainly hope the RSA makes it through. I could use it, and would use it, and most people are in the same boat as I am with this one.

Posted by john at February 4, 2003 05:42 PM

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